Northern Rock Cash Used to Fund Deal

A third of the £747 million cash price that Sir Richard Branson’s Virgin Money is paying to buy Northern Rock will be funded from the state-owned bank’s current capital base, the Financial Times has discovered.

According to people involved in the deal, Virgin believes it can extract up to £250 million of “excess capital” from Northern Rock – as well as a further £150 million or so from Virgin Money – leaving the combined business with a thinner capital cushion.

Virgin Money announced on Thursday that it would pay £747 million in cash plus £150 million of new convertible debt for Northern Rock – the bank that epitomized the credit boom and bust before it was nationalized three years ago. A further sum of up to £130 million will be payable to the government depending on performance and the timing of any resale of the business.

Virgin Group is injecting only £50 million of cash alongside a similar amount from little-known Abu Dhabi fund Stanhope Investments, and close to £260 million from US financier Wilbur Ross. The rest is set to come from release of the nearly £400 million in “excess capital” from Northern Rock and Virgin Money.

The revelation of the structure behind Virgin’s deal makes no difference to the amount of money the taxpayer will receive, but could reduce money that might otherwise be deployed for loans or expansion. It also risks further infuriating critics of the deal, who on Thursday pointed to the loss of at least £400 million that the government is making compared with the bail-out money it injected.

Lord Oakeshott, the Liberal Democrat peer, said he was concerned whether Sir Richard Branson and his overseas backers might be planning an “asset strip” before the deal was formally completed.

“If he is going to do an asset strip for £250 million of capital it could mean that if things go wrong again we would have to rescue them again.”

Northern Rock and Virgin Money both have core tier one capital ratios, the key measure of financial strength, in excess of 20 percent – double the level of most banks.

Virgin Money has been told by regulators that it cannot run on a thinner cushion after the acquisition, people close to the bank said. But bankers are counting on the Financial Services Authority to approve a plan allowing them to cut the ratio for the combined business to about 15 percent.

The strategy of releasing trapped funds from an acquisition target is not unique to the case of Northern Rock.

When Resolution, the specialist acquisition vehicle, acquired Axa’s UK life insurance business last year, it set about freeing up £1 billion of “orphan assets”. Regulators, however, have held up that process.

Some observers believe the FSA may take a similar stance with Virgin Money. “The complexity and intensity of scrutiny by the FSA cannot be underestimated,” said one person close to the deal.

Another admitted that “there is still more work to do”. The FSA declined to comment.

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